There are many circumstances in which an actual or potential tax charge may be based on the market value of an asset. This can be a requirement where a transaction takes place at undervalue (for example, a gift) or between connected parties (where there is unlikely to be a freely-negotiated price). The same will be true where an asset is provided as part of an employee’s or director’s remuneration. The requirement for valuation frequently arises where shares in unquoted companies are transferred.
The legal requirements for fiscal valuation do, in some ways, appear to be common sense. The valuation should be the amount that the asset would fetch in a transaction between a willing vendor and purchaser. However, where there is, in reality, neither a vendor nor a purchaser, the law requires the valuer to imagine certain features for the transaction and the market in which it takes place. This can lead to unexpected – and sometimes advantageous – outcomes.
An example of planning we have implemented
Scenario
A client owned a successful company with ambitious growth plans. At the time of the transaction concerned, the company had profits of around £1 million. An intended expansion into a new market gave the realistic prospect – even expectation – that profits would grow to at least £5 million. Key to these plans was the role of the Commercial Director. To retain his services and to incentivise him to drive expansion, it was decided to make him a shareholder in the company and it was decided to give him 10% of the equity.
It was fully expected that a 10% shareholding would be worth around £1 million at least by the time an exit came around.
The tax planning opportunity
The internal expectation of a high value was not necessarily reflected in the hypothetical valuation required for tax purposes. The director fully appreciated the potential of the business, but the tax rules require the valuer to imagine a transaction between hypothetical parties. The rules also have something to say about the information that can be used for the purposes of the valuation. For a small minority valuation, that information is restricted, broadly, to information in the public domain.
Looking only at historic published information (and ignoring prospects for expansion which rested on confidential arrangements and plans) a far lower valuation was justifiable.
By using the Enterprise Management Incentive scheme it was possible to agree a valuation with HMRC in advance.
The result
The valuation could largely ignore the key plans for expansion. Taking further discounting factors into consideration it was possible to agree a valuation of only £120,000. By agreeing to pay that amount to acquire the shares (even though nothing will be payable until an eventual share sale) the director will have prevented any income tax charge on a benefit worth around £900,000. There will only be a Capital Gains Tax charge at 10%.
The potential opportunity with fiscal valuation stems from the difference that often exists between a client’s perception of the value of shares (or another asset) and the valuation produced by the process required by tax law.
